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Why Blue States Should Think Twice Before Starting a Tax War

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As we’ve noted before (here, here and here), some high-tax states are looking for ways around the $10,000 limit on state and local tax deductions imposed by the Republican tax bill.

New York Gov. Andrew Cuomo has threatened to sue the federal government over the new rules, saying they are part of an “economic civil war” designed to hurt wealthier states. Lawmakers in California advanced a bill this week that would allow residents to make charitable donations to the state in exchange for tax credits to use on their federal returns worth 85 percent of the donation. Other states are exploring that approach, as well as the possibility of using payroll taxes to reduce state income taxes.

The blue state effort to get around the new rules has gained a lot of attention, but tax experts have their doubts about both the legality of the proposed workarounds and the effects they might ultimately have. The conservative Tax Foundation pointed out last week that, if successful, the efforts would be regressive, with the benefits flowing overwhelmingly to wealthier taxpayers.

Earlier this week, Leonard Burman and Frank Sammartino of the centrist Tax Policy Center made much the same point, arguing that the $10,000 limit on state and local tax deductions is “one progressive element of a law that disproportionately benefits the rich.”

More broadly, TPC warns that state lawmakers may be opening a can of worms – especially if Congress responds by changing the rules again -- and the end result could leave local taxpayers worse off while siphoning tax revenues from the federal government. “If they are not careful, they could create a complex web of state tax benefits that mostly help the well-to-do, exacerbate the federal government’s fiscal woes, and may lead to unintended consequences,” Burman and Sammartino write.